At Tuesday’s closing price of $193.92, the recently issued American depositary receipts of SK Hynix were commanding a 38% premium to Wednesday’s closing price of its local shares listed in Seoul.
How long could this persist? Not very, if the Korea Securities Depositary allows mutual conversion of the ADRs and the local shares at the end of this month. Most likely a premium of some sorts will endure because American investors will prefer a locally-traded, dollar-denominated asset for easy investing and exchange-traded funds will do likewise. However, once depositary receipts can be borrowed, allowing traders to short them, and conversion is permitted, then much of the premium will be arbitraged away.
The arbitrage is not frictionless. Commissions or trading costs are payable on both sides, there is a conversion fee to create the ADRs, there are borrowing costs on the ADRs also. However, compared to a premium of 38%, these are negligible and without unforeseen obstacles, hedge funds and proprietary trading desks will be queuing up to put the trade on.
According to a Korean language news report, the Korean depository reported that that applications for conversion will be possible from July 29. Coincidentally, that’s also the day on which SK Hynix will release its second-quarter results.
In pre-market trading Wednesday, the ADRs were indicating 5% lower so already showing the premium beginning to shrink. It’s worth recalling that when the ADRs were priced last week, the strike was only a 3% premium to the locals.
Options related to SK Hynix ADRs also began trading Tuesday. Therefore, if investors were buying calls to exploit future upside potential in the stock, then derivative traders would be looking to buy shares to hedge themselves.
An important factor to consider will be the number of ADRs that the KSD will allow to be created. At present, Morgan Stanley trading desk for instance, believes that number will be 2.5% of total shares outstanding. The more restrictive the ADR conversion mechanics, the wider the premium will be.
Premia on ADR listings can also be affected by sentiment towards emerging markets in general, shrinking when the asset class is out of favour and vice versa, The premium can also be impacted by liquidity. If Nasdaq generates sufficiently high volumes then there is more incentive to hold the ADRs. Tuesday, for example, saw roughly $280 million of turnover in the U.S. but this was dwarfed by Wednesday’s volume in Korea where around $8.5 billion of shares changed hands. The shares closed up almost 9%.
Another reason that may serve to contract the premium would be the possible U.S. listing of a depositary receipt for Samsung Electronics, Korea’s largest stock and a direct competitor for SK Hynix in many areas. If Samsung were also to tap U.S. investor demand for memory chip makers then the competition might lessen the appetite for SK Hynix, as it would no longer be the only game in town.
The example of Taiwan Semiconductor Manufacturing Company, the world’s largest chip maker may be instructive. The premium on its ADRs is currently 11% but in the last few decades it has swung wildly between lows of just 1 or 2% and highs of 26%. As U.S. investors have bought into the AI capex supercycle, the majority of trading has migrated to the U.S., where it has reached 60% of total turnover.
Other competitors for the semiconductor investment dollar are also new on the block. In mainland China, DRAM chip maker CXMT is also planning to list Thursday at a valuation of $85 billion, although much higher figures have been suggested by grey or shadow market trading. Nand chip maker YMTC also plans to list in Shanghai shortly with a valuation of $44 billion bandied around the local market.
